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Canadian dollar will fall to 85 cents this year, says TD Economics

TORONTO - Watch for the loonie to lose more of its luster this year, according to two well-known bank economists.

Craig Alexander, chief economist for TD Economics, warned Thursday that consumers could see the Canadian dollar slide as low as 85 cents US by mid-year if the current environment continues.

He said factors that have impacted the currency so far this year, from an increasingly dovish tone from the Bank of Canada to tapering of monetary stimulus by the U.S. Federal Reserve, will continue to drag down the loonie.

"TD Economics expects that the factors which have taken the Canadian dollar lower are unlikely to shift over the next year or so," wrote Alexander in the report, titled "The Call of the Loonie."

"Canadaâ€™s economy is forecast to underperform the United States, interest rate hikes remain quite a ways off and the outlook for commodity prices is pretty flat, on average."

The report noted that a strengthening U.S. greenback and Bank of Canada governor Stephen Poloz's perceived stance on a weakened loonie have led the currency's fall to a four-year-low.

"(Poloz's) messaging has led markets to believe that the Bank of Canada will not be raising interest rates for quite some time and that the bank is very comfortable with a weaker loonie," Alexander said.

Senior economist Benjamin Reitzes echoed the same sentiment in a separate report for BMO Capital Markets, forecasting that the Canadian dollar will fall to 87 cents later this year.

The loonie rose slightly Thursday, up 0.11 of a cent at 89.57 cents US at mid-afternoon.

Both reports also predicted that although the loonie will decline in the next few months, it has an opportunity for a small rebound back to the low 90s in the latter half of the year if there are no low inflation induced rate cuts by the Bank of Canada.

"Since governor (Stephen) Poloz took the helm at the bank, each statement has become more dovish than the last," Reitzes said. "He can't go much further down that road without easing policy and markets are pricing in slight odds of a rate cut this year."

These outlooks were some of the lowest loonie forecasts issued so far by a major bank. Most economists had previously predicted that the currency would fall to around 90 cents this year, although it broke through that level earlier this week.

The Canadian dollar has seen its value against the U.S. dollar drop more than 10 cents over the past year. The fall has come amid moves by the U.S. central bank to scale back its stimulus measures, which has led U.S. bond yields to rise.

Meanwhile, the dovish tone on interest rates from the Bank of Canada has had the opposite effect, and has driven bond yields in Canada lower.

Earlier this week, the Fed cut back its bond purchases by another US$10 billion to $65 billion a month. It was the central bank's second such move to cut back the program to help keep long-term interest rates low.

The Fed's monthly bond purchases over the last few years has plumped up markets, but now that the stimulus is being pulled back, the U.S. dollar has strengthened on expectations of higher interest rates and a stronger economy.

Reitzes said the loonie is currently at "fair value" if based on factors such as commodity prices, which have also fallen in the past year.

"Itâ€™s clear that markets have soured on the loonie. Until expectations for commodity prices turn higher or the Bank of Canada changes gears toward more hawkishness, the risk is tilted toward more weakness than expected," he said.

"That should bring a smile to exporters and some domestic retailers, but will markedly raise the price of travelling abroad and put a serious dampener on cross-border shopping enthusiasts."